I have been a contrarian investor for decades and believe that patience pays off well in the long run. However, there are some ground rules to minimise the probability of failures. Firstly, one should not play contrarian for the sake of being a contrarian — or to stay away from the crowd. Secondly, a contra play is in those sectors or companies which are not doing well at a point in time. So, a good management in an underperforming sector is always better than an unscrupulous management in a good sector. The latter could be a good momentum play but the former, possibly, is a good contra play.
When Tata Motors had bought Jaguar Land Rover (JLR) for $2.3 billion in 2008, the Street gave it a thumbs-down with the stock tumbling 80% from its pre-announcement levels. One of the major reasons for such a crash was the huge debt of around Rs.220 billion that Tata Motors got saddled with, which till then was virtually debt-free. Secondly JLR, an albatross around Ford’s neck, was struggling for survival. There was a global slowdown and dealers were in distress. Experts believed that there were limited synergies between Tata Motors’ India operations and JLR. To top it all, Tata Motors got into a controversy with the chief minister of West Bengal, Mamata Banerjee, resulting in the company abandoning the partially built Nano plant at Singur, losing over Rs.10 billion in the process. In short, it couldn’t have got any worse for Tata Motors.
The turnaround story which played out, thereafter, resulted in the stock fetching a 20x return in six years, and even as of today, despite underperforming for the past two years, it is still up 8x, which is a good return by any yardstick. It’s interesting to check what the management did in those couple of years scripting the turnaround.
The asset of JLR was great engineering, committed employees and a good brand. The three-pronged approach of the Tatas for cash management, cost control and new products worked out well. From a £400-million loss in 2008 to a £2.6-billion profit in 2015, Tata Motors ended up contributing 50% to the group’s profits. However, it was far from a fairy tale ending.
The Silver Lining
A global slowdown and the trade war, uncertainty over diesel in Europe, and the additional diesel taxes in the UK, resulted in an one-time impairment cost of Rs.280 billion in Q3FY19. That shocked investors, resulting in the stock cracking to a multi-year low of Rs.129 from Rs.182, before consolidating to close at Rs.150 on the day of the result. Over 80% of JLR vehicles sold worldwide are produced in the UK, and Brexit is one of the biggest challenges staring at JLR. But challenges are something that separates the men from the boys. For the Tata group, this is yet another opportunity to prove its mettle.
The newly built 150,000 units facility at Slovakia, in addition to the units in China and Austria, should, hopefully, reduce the concentration risk. The company’s £22 billion investment in JLR over the past few years should also fetch dividends. One of the possible big success stories could be the Jaguar I-Pace and the Range Rover PHEV. The former is already touted to be the most formidable competitor for Tesla — a battery-electric cross-over having a range of around 240 miles and an acceleration to 60 miles per hour in less than 4.5 seconds.
Home Advantage
Back home, Tata Motors is the largest commercial vehicle (CV) company and the fourth-largest passenger vehicle (PV) player in the country contributing 30% to the combined turnover of Tata Motors-JLR. A peculiarity of this combine has been the balancing act between Tata Motors India and JLR over the past decade. Whenever Tata Motors India did well — it was pulled down by JLR losses and vice versa. However, JLR’s profitability during the Tata Motors India’s lean period more than compensated the latter’s losses, thus, resulting in the wealth creation for shareholders. Tata Motors, through its subsidiaries and associates (other than JLR), has operations in South Korea, Thailand and Spain.
Possibly for the first time over the past two decades, Tata Motors India has got its PV act right. Tata Nexon, touted as the safest car in the mid-range, had Anand Mahindra, chairman of M&M, congratulating his competitor, Ratan Tata, on the achievement. Tiago is another top-selling model for Tata Motors. The latest premium launch from its stable, Harrier, built on the JLR platform, has a three-month waiting period. With this, it has the complete range from affordable to premium. The current portfolio covers about 60% of the market, and is expected to touch 90% by 2022.
This Diwali, we can expect a premium hatchback, codenamed X451, built on the in-house developed Alpha platform. It has been showcased as Altroz at the recent Geneva Motor Show. The company also unveiled three other products, a small sports utility vehicle, H2X, and Buzzard Sport (known as Harrier in India) at the same event.
The heavy and light CV-cycle seems to have also turned for the better what with Tata Motors India churning out profit of Rs.20 billion for the nine months ended December 2018.
Staying The Course
The Tatas are now implementing a Turnaround 2.0 strategy. On the JLR side, it would focus on cost control, including reduction in workforce and inventory. The auto major has a revised go-to-market plan, and, hopefully, will be able to generate free cash flow before the end of CY19. However, analysts expect that to happen only by FY21, given the investment needed for electric vehicles and hybrids. If the strategy works well, we could have both Tata Motors India and JLR performing well in tandem, unlike the balancing act in the past.
I would place my trust on the Tatas to succeed in rejuvenating the floundering JLR and this has been further strengthened by Tata Sons’ move to buy around 380 million shares of Tata Motors over the past six months, thus increasing its holding to 34.5%, and overall promoter holding to 37.6%. Hence, this contra-call is more a bet on the management to turnaround the company despite a tough environment as against betting on the environment to improve in the natural course. At the current price, the stock is trading at 4.2 times (FY20) and 3.6 times (FY21) EV/Ebitda, a valuation metric used for companies with high debt.
Tatas have rarely disappointed its shareholders and, thus, I believe they will leave no stone unturned to ensure that JLR 2.0 provides a far more consistent and rewarding proposition in the coming years.
The author has an interest in the stock and has also recommended it to his clients
